PRICES AND COSTS AT THE PUERTO REAL BEARING PLANT The Price Review Group of Delphi Chassis was holding a meeting at the firm's general headquarters located in Dayton (Ohio, United States). Delphi Chassis was a division of Delphi, A.S., a subsidiary of General Motors (GM) comprising all the automotive parts companies of the GM Corporation. Wheel bearing manufacturing was carried out at the Delphi A.S. plant. The meeting had been called because Delphi wanted to participate in a tender process run by Opel, GM's assembly subsidiary in Europe, for a new model of wheel bearing called Generation III, which would be manufactured at the Delphi Chassis plant in Puerto Real (Cadiz, Spain). The new bearing was known in the division as T-3000, and would be mounted on the Astra model. In June 1996, the bearing plant in Puerto Real was going through a critical period due to sustained reduction in production and sales since 1994 (see Table 3). After examining available operating and finance data, some of those present at the meeting proposed that rather than making an offer to Opel to manufacture the T-3000, it might be better to close down the plant. DELPHI, A.S. AND THE AUTOMOTIVE PARTS MARKET Delphi, A.S. was the leading worldwide manufacturing company of automotive parts and systems (see table 1). It was followed by Visteon Corp., - a company closely linked to Ford - and Robert Bosch. Visteon and Bosch were, however, a considerable distance behind Delphi on the world market. While Delphi had a turnover of approximately 26,480 million in 2000, its competitors didn't even come close. Delphi, A.S. sales were nearly 42% greater than those of Visteon Corp. (E18,569 million ) and 48% higher than those of Robert Bosch (E17,800 million). Data and locations modified for the sake of confidentiality.PRICES AND COSTS AT THE PUERTO REAL... Table 12 RANKING OF ORIGINAL EQUIPMENT SUPPLIERS BY SALES (1996-2000) Millones euros 30.000 25.000 20.000 15.000 10.000 5.000 1996 1997 1998 1999 2000 - Delphi, A.S. Corp. - - - Visteon Corp. - - - - Robert Bosch GmbH - Denso Corp. - Lear Corp. Source: Automotive News (2001, 1999 y 1998). TERRITORIAL ORGANISATION Delphi, A.S. was divided into four geographic areas: North America, South America, Asia Pacific and Europe. The headquarters of North American and world operations was in Troy (Michigan, United States). It had three regional offices, located in Sao Paulo, Tokyo and Paris. This overall territorial organisation of Delphi, A.S. was maintained for each one of its divisions, including Delphi Chassis which included the wheel bearings section. The wheel bearing section had its parent plant at Sandusky (Ohio). The plant had been built in 1946, with more than 1,600 employees and a surface area of 121,000m2. The bearings division centralised its research and development functions at this plant, which meant that the remaining factories were technically dependent on the parent plant. Automotive bearing manufacturing had given rise to different generations of products, in line with different technological developments. The plant at Sandusky had been innovative in manufacturing the third generation of bearings, the production of which began in 1979. With a capacity of 60,000 bearings a day, more than 200 million of these third generation bearings had been manufactured at Sandusky. THE MARKET Delphi Chassis's main competitors in the European bearing sector were SKF and FAG. These companies had, among other strong points, the capacity to produce all the generations of bearings. The general nature of bearing production was important, as manufacturing of conventional bearings, intended for the parts market, yielded a high profit margin (due to scant investment in technology). On occasions, there was the added factor that equipment used in the manufacturing process had been financially amortized. In addition to their role as general producers, SKF and FAG had a high degree of vertical integration and considerable specialisation in bearings. 2 Data shown in Table 1 depicts the general trend of the industry, and this applies to the period addressed in this case.PRICES AND COSTS AT THE PUERTO REAL... However, those strong points translated into weaknesses in comparison with Delphi, A.S., given that Delphi operated in all the segments of the parts market such as, for example, sensors, steering racks, suspensions or radiators. The horizontal nature of Delphi, A.S. allowed it to offer integrated solutions to its customers, who appreciated having a reduced number of suppliers who knew their needs. This expedited negotiations considerably. Finally, another factor in favour of the wheel bearing factory at Puerto Real was the fact that the competitors were located in countries with high direct labour costs, such as Sweden, Germany and Italy, which made their offers considerably more expensive. In 1996, the world market share of third generation bearings was as follows: Delphi, 57%; SKF, 19%; FAG, 11%; NSK, 7%; and Koyo, 5%. However, SKF was the leader in Europe, followed by FAG, which also had a greater share of the European market than Delphi, A.S. THE WHEEL BEARING FACTORY IN PUERTO REAL At the beginning of the eighties, GM set up two parts factories in Puerto Real. The object of these factories was to produce suspension systems in one and steering systems in the other. At the end of that decade, the decision was made to build a third factory that would leverage the synergies of the other two, i.e. the industrial land and the knowledge that employees and management had of the European automotive parts market. The decision to start up the new bearing plant at Puerto Real had been based on the fact that the general strategy of Opel, a European subsidiary of GM, was to make the supply chain less expensive. Opel aimed to pressure the bearing suppliers by bringing a supplier belonging to its own group onto the European market. The general scope of the production objectives of the Puerto Real bearing plant included the possibility of sporadic offers for small-volume orders intended for the Brazilian market. Construction of the factory began in 1989 and production commenced in 1991. Investment amounted to E30 million and the manufacturing capacity was 1,800,000 bearings per annum. In the context of the three Delphi A.S. plants in Puerto Real, the bearing plant had autonomy in relation to the basic manufacturing functions. This emphasis on production and the fact that some auxiliary functions were shared with the other plants located at Puerto Real meant that the factory manager's responsibilities were similar to those of an operations manager, that is, responsibility for all the aspects related to production, quality and supplies. The auxiliary functions provided by other GM Corporation sectors (for example, plants of other divisions located in Puerto Real or the parent plant at Sandusky) were organised as follows: the bearing plant shared services related to human resources, supplies and finance with the suspension and steering systems factories, as well as some of the services related to laboratories. The parent plant supplied the new bearing plant with services related to research and development and a fair share of marketing services. As part of generic operations, the new bearing plant was equipped with metallurgical and metrological laboratories, to provide access to services that the shared laboratories used by the other two plants could not supply due to their specific nature. Specifically, the laboratories' task was to determine the quality of the parts provided by the suppliers. This type of quality control is critical in the case of steel, the basic material in bearing manufacturing, which in turn is closely linked to vehicle safety. The shared use of support activities had immediate consequences for their associated costs. From the overall standpoint of the three factories located in Puerto Real, such costs should be considered fixed. Setting aside inflation-related increases in such costs, substantial modifications in its total amount, E5,282,002, would require increases/decreases of at least 50% in the overall activity of the three factories. Table 2 shows the how each one of the three plants located in Puerto Real allocated these costs.PRICES AND COSTS AT THE PUERTO REAL... TABLE 2 DISTRIBUTION OF COSTS IN RELATION TO COMMON SERVICES CONSUMED BY THE PLANTS LOCATED IN PUERTO REAL (1996) Figures In Euros Expense Suspension Steering Bearing Total Plant Plant Plant Management 42,099 42% 42% 16% 100% Finance 1,060,644 42% 42% 16% 100% Administration 1,102,743 100% Procurement 1,121,847 38.5% 45.2% 16.3% 100% Transport 126,610 36.6% 59.7% 3.7% 100% Materials 1,248,457 100% Personnel 601,731 42% 42% 16% 100% Security 625,823 42% 42% 16% 100% Health service 244,076 35% 58% 7% 100% Human Resources 1,471,630 100% Plant engineering 195,225 42% 42% 16% 100% Laboratory 533, 162 24% 67% 9% 100% Central quality 291,477 26% 66.4% 7.60 100% Other inspections 65,981 50% 50% 0% 100% Supplier development 373,327 33.33% 50% 16.67% 100% 1,459,172 TOTAL 5,282,002 Source: Company. The first major contract the factory obtained was for the J-2700 model, used in the nineties on the Opel Vectra. Securing this contract brought a boost for the factory and enabled it to achieve a certain volume of production (see table 3). TABLE 3 LABOUR, SALES AND OPERATING PROFIT OF THE BEARING PLANT AT PUERTO REAL (1990-1997) Sales Operating profit Direct labour Indirect labour (thousands of thousands of euros) (number of employees) (number of employees) euros) 1990 0 5,948 1991 4,745 -5,548 22 1992 19,83 6,916 52 1993 9,904 -1,957 89 1994 13,94 -1,051 62 1995 10,95 1,683 56 36 1996 6,442 -69 56 34 1997* 1,774 -8,679 53 37 (*) Estimated data Source: Company. PRODUCTS AND MANUFACTURING The wheel bearing is the element that supports the wheel and on which rotation takes place. It is an essential part of the car, on which its functionality and safety depends, as breakage of the bearing axle may mean loss of the wheel with the added risk of a serious accident. It is due to this that bearing tolerances are extremely strict. At the very least, a higher friction than usual has the immediate effect of causing a loss of power in the vehicle and greater fuel consumption. It is however, more than likely that it would give rise to serious safety problems. Quality is thus a central factor in manufacturing bearings, and in this respect the plant at Puerto Real always reported exceptional results, to the point of boasting single-digit figures on the demanding defective partsPRICES AND COSTS AT THE WERTD REAL... per million dppm indicator. Production ofthe third generation bearing rst requires the axle and housing to be manufactured. These two elements of the bearing undergo very similar manufacturing processes. The process begins with heat treatment, performed by induction and checked 100% automatically; it is then drilled and taped and then the rst grinding takes place. The interior ring is then pressed, performing the clamping, nal grinding and lapping; all the operations are automatically controlled. The ring manufacturing process consists of grinding the interior diameter, grinding the external track and checking. The nal assembly is then performed. Third generation bearings are distinguished from the previous generation by their level of integration: the bearing leaves the factory preloaded, and all that remains is to bolt it onto the vehicle. The manufacturing process of third generation bearings is highly automated, which means that the cost of materials constitutes the main part of the total cost of the product (50-67% depending on whether it is conventional or has built-in ABS technology). 0n the other hand, the cost of direct labour is relatively low and stable, being about 10% of the production cost. The remaining costs are indirect. THE T-3000 AND THE PRICE REVIEW GROUP At the time of the tender the T-3000 was a highly innovative ABS bearing. The product was required by Opel for the assembly of the most advanced models of the Vectra and Astra cars. The offer would include the mounting of the T-3000 on the Opel Astra. From the perspective ofthe Puerto Real factory, the T-3000 contract would have a critical impact. The contract involved manufacturing one million advanced-generation bearings per annum, for four years. Said volume of production would increase the capacity used, which at that moment was below all expectations, and it would improve the nancial feasibility of the plant. Moreover, obtaining the contract would have the added effect of proving to competitors that the Puerto Real factorywas able to compete in the high-technology bearing sector. The traditional competitors, SKF and FAG, were aware that if they got the contract, they would achieve not only considerable nancial prot, but also gain market with Opel, a key customer on the European automotive market. Moreover, they would seriously endanger the survival of the Puerto Real factory, which would be almost certainly be forced to close down. If these expectations materialised, SKF and FAG would eliminate an inconvenient competitor and would consolidate an oligopoly regime on the European bearing market. Due to the innovative nature of the new bearing, it was not completely possible for the Price Review Group to estimate the price range of the competitors' offers. Although the variable costs of the competitors could be estimated to a reasonable extent, it was very difcult to ascertain precisely because it was not kn own how the competitors would assign the costs of research and development to the nal price of the product. For that reason, the price range foreseen for the offers by competitors was broad (between 20-30 euros), so the information it provided the Price Review Group was of little use. This was the background for the meeting of the members of the Price Review Group. They knew that they either had to full or improve on the general objective of the GM Corporation, which was to obtain a payback of at least two years. As the basis of the meeting, the members of the Group had requested the Puerto Real plant to estimate the costs of manufacturing the T-3000, as well as the investments required to undertake the project (see table 4). At the same time, in order to evaluate the possibly of relocating the bearing plant, a nancial report was requested ofthe cost of dissembling the machinery, transporting it to another country and subsequently installing it at the new location. This gave a gure of 2.5 million euros for any ofthe countries considered, as greater transport costs, in the case of Slovenia and Poland, would be compensated by savings on the installation. El PRICES AND COSTS AT THE PUERTO REAL... Table 4 ESTIMATION OF COSTS AND INVESTMENTS REQUIRED TO UNDERTAKE THE T-3000 PROJECT (1996) In euros Total investments 2,479,843 it in machi 2,299,153 - Investment in personnel training and industrial organisation methods 180,690 Production cost per unit: 33.57 - Materials 20.76 Direct labour 1.21 Other variable costs 3.97 - Fixed unit cost 7.63 (*)Detail of fixed unit cost: -180 Consumption of tooling 1.01 -181 Indirect labour 0.07 -182 Incremental fixed costs 0.13 -183 Existing fixed costs 6.42 Source: Company. In Table 4, "Total investments" refer to the acquisition of machinery and tooling as well as training courses for employees. Such costs were regarded inherent to the eventual production of T-3000 Other variable costs" refer to transportation and consumption of utilities by machineries assigned to the T-3000 project. The item "Fixed Unit Cost" comprises aspects such as consumption of to oling that is specific of T-3000 production; "Indirect Labour", supervisors and foremen assigned to this project; and "Incremental Fixed Costs", which encompasses items such as additional consumptions of air conditioning as a consequence of the expansion in manufacturing space. Finally, "Existing Fixed Costs" refers to costs already incurred by the setting and that are allocated to the T-3000 project. For the purposes of eventual relocation of the plant, the information that had reached the meeting of the Price Review Group concentrated on three alternative countries: Portugal (a member of the European Union) and Slovenia and Poland (countries that could be expected to join the European Union in a future enlargement). Table 5 shows some data on these three countries and on Spain. Furthermore, Table 6 depicts the educational background of site employees. Finally, the Price Review Group knew that the eventual tax savings that could be obtained by relocating the factory in Poland or Slovenia would compensate for the tariffs paid on products from those countries entering Germany and, definitively, the European Union. Significant saving was therefore foreseen on the cost of the materials in Portugal, Poland and Slovenia, in the hypothetical case of wheel bearing production being transferred to any of those countries. These savings would be due to the joint effect of factors such as the lower general level of prices and lower internal demand for such materials. This last aspect would afford the company greater negotiating power over local suppliers. Specifically, and in these three countries, the cost reduction foreseen compared with Spain would be 30.50% in the first year, and this would result in a final cost of E14,4282 for year 1. In the second year, once bonds were established and developed with suppliers the cost of materials for any of the countries considered for the relocation would be E12.70512.PRICES AND COSTS AT THE PUERTO REAL... TABLE 5 COMPARATIVE DATA ON COSTS, TRAINING AND PRODUCTIVITY IN EUROPEAN COUNTRIES (1996) SPAIN Portugal Poland Slovenia Minimum annual salary (in euros) 5950 4704 2772 208 Population with university education between 20-29 years old 28.1% 26.1% 30.6% 30.5% Annual working hours 1,820 hours 1,832 hours 1,992 hours ,943 hours Increase in productivity (annual rate; four years) 0.85% 1.01% 4.3% 3.7% Source: Eurostat and OECD TABLE 6 EDUCATIONAL BACKGROUND OF EMPLOYEES AT THE PUERTO REAL SITE. SPAIN Engineers 5-year University Degree (Licenciatura) 6% 3-year University Degree (Diplomatura) 35% Professional Schoo 24% Basic 30% THE MEETING At the meeting on 17 June 1996, the members of the Price Review Group had to undertake the following: 1.- Consider the price of the wheel bearing system for the Astra that could be proposed to Opel if the part were manufactured at Puerto Real. 2.- Consider the possibility of relocating the Puerto Real factory to any of the three European countries (Slovenia, Poland or Portugal) and making Opel an offer based on manufacturing the wheel bearing there 3.- Assess the supporting data for the decisions under consideration. 4.- Recommend whether the Puerto Real bearing plant should be relocated or not. 5.- Comment on the group dynamics as well as on the supporting information for decision making